* Spare cash in banking system at lowest since Sept 2011
* Last time liquidity was so low it spurred ECB action
* Quantitative easing still seen as unlikely option
By John Geddie and Eva Taylor
LONDON/FRANKFURT, April 24 The amount of spare
cash in the euro zone banking system fell to its lowest levels
in 2-1/2 years on Thursday, pushing up short-term money market
rates and adding impetus for the ECB to loosen policy further.
The fall in liquidity comes as European Central Bank
policymakers have ramped up rhetoric to talk down a strong euro
whose resilience could stoke disinflation in the euro zone and
torpedo its fragile economic recovery.
ECB President Mario Draghi said weaker inflation could
prompt broad ECB asset purchases and the bank could also start
charging banks for parking cash with it overnight if there was
an undue tightening of its policy stance.
Excess liquidity - which is the measure of money that banks
have beyond what they need for their day-to-day operations -
fell to 92.937 billion euros ($128.53 billion) on
Thursday, the first time it has dropped below 100 billion euros
since September 2011.
The last time liquidity fell so low it nudged the ECB to
introduce its Long-Term Refinancing Operation, a series of
emergency loans to banks.
Now, it is likely to add further incentive for the ECB to
act on an "unwarranted" tightening of short-term money markets,
one of the scenarios the central bank has said could prompt
fresh policy action.
Money market rates came under some upward pressure on
Thursday, though expectations of ECB action contained the rise.
The euro zone overnight bank-to-bank lending rate, settled
around 0.22 percent, up about 2 basis points from the
previous day but still below the rate of 0.25 percent which the
ECB charges banks to borrow cash, known as the refinancing rate.
One-year forward rates - the most traded
money-market instrument, which shows where one-year contracts
are expected to be in a year - spiked 3 bps to as high as 0.24
"As overnight rates get closer to, or even beyond, the
refinancing rate it will be a technical pretext for the ECB to
carry out additional measures at its next meeting," said Elwin
de Groot, senior economist at Rabobank.
He said this was likely to be a cut in the refinancing rate
and a suspension of weekly operations whereby the ECB soaks up
money it spent on government bonds at the height of the debt
crisis, referred to as sterilisation of the ECB's Securities
Market Programme (SMP).
Groot said the ECB was unlikely to embark on a full-blown
asset purchase programme, also known as quantitative easing, in
the near term because the benefits of that would be slow to come
Others said suspension of SMP sterilisation would only be a
stop-gap measure to boost surplus cash in the market and keep
short-term rates subdued, but that persistent weak inflation
would eventually push the ECB into more radical action.
"It (fall in excess liquidity) opens the door for perhaps
not quantitative easing now but more liquidity focused action
such as suspending sterilization of the SMP permanently," said
Benjamin Schroeder, a strategist at Commerzbank.
"This would probably be a short-term solution though, and we
would probably see more action later in the year."
BETTING ON ACTION
The ECB next meets on May 8. In the forward market, EONIA
rates coinciding with the ECB meetings for the rest of the year
remain 2-7 bps below the spot rate, indicating that investors
are betting on further policy action.
Not all agree, however, that the fall in excess liquidity is
of immediate concern. G+ Economics chief economist Lena Komileva
said short-term money market rates are still "well within
ranges" and are no trigger for liquidity easing.
"For a policy reaction function, the decline in excess
liquidity itself is not a trigger, but the increase in
short-term volatility is worth watching," she said. The
liquidity decline was mainly driven by banks repaying the
long-term crisis funds, which was generally "not a bad thing",
"The stability of medium-term rates suggests that bank
deleveraging is working, which makes them less reliant on
central bank funding," she said.
($1 = 0.7231 euros)
(Writing by Emilia Sithole-Matarise; Graphics by Vincent
Flasseur; Editing by Susan Fenton)